Growth in cloud computing was a boon for cloud stocks in recent years, but another wave of growth is coming as more companies ramp up their investments in artificial intelligence (AI).
Market intelligence firm IDC expects AI to drive one-third of the total growth in public cloud services through 2025. AI could accelerate the data migration from on-premises servers to the cloud, which makes now an ideal time to buy top cloud stocks that are trading at discounts to their previous valuations.
Here’s why Amazon (AMZN 1.92%) and Snowflake (SNOW 0.12%) are well-positioned to benefit from these trends.
In 2022, Amazon stock fell to its lowest valuation on a price-to-sales basis in almost 10 years. It’s easy to lose sight of how important valuation is to generating good returns when stocks are consistently moving higher in a bull market. But it’s no coincidence that high valuations usually precede bear markets, while low valuations set the stage for new bull markets.
The market obviously didn’t like the e-commerce leader’s slowing revenue growth last year amid the uncertainty in the economy. Nonetheless, the stock sells at an attractive valuation ahead of an emerging new growth opportunity for Amazon Web Services (AWS). Amazon is currently in the process of improving its cost structure to boost its profits. This will require it to lower its investments in fulfillment infrastructure this year. But it’s telling that one area where it doesn’t seem to be holding back is investing in generative AI, which uses text and video to create new content, to support growth in AWS.
AWS makes up 17% of Amazon’s total revenue, but it was responsible for virtually all of its profits last quarter. It maintained its leading position in the cloud market, which means it could soak up a lot of the incremental spending that is expected to come over the next several years.
“Few folks appreciate how much new cloud business will happen over the next several years from the pending deluge of machine learning that’s coming,” CEO Andy Jassy said on the first-quarter earnings call. Machine learning is the subset of AI that involves training systems to spot patterns, make decisions, and improve their processes. Amazon has invested in its own computing accelerator (AWS Inferentia) designed to power large language models and generative AI applications.
Given that over 90% of information technology spending is still devoted to on-premises systems, as Jassy noted, AWS still has a tremendous long-term growth opportunity. But Amazon stock is still well off its previous highs, making it a top cloud stock to consider buying in 2023.
Because Snowflake’s data cloud platform can be deployed on Amazon Web Services, a lot of the points supporting Amazon’s growth opportunity are valid for this company, too. The shift in global IT spending from on-premises servers to the cloud is a huge opportunity for Snowflake, and the arrival of generative AI only widens that opportunity.
Snowflake offers its clients the ability to store, analyze, and distill insights from their data. It even offers a data marketplace where those clients can share and exchange data with each other. This is a key competitive advantage that supports a sticky user platform.
Its stock price has been choppy lately as Wall Street tries to get a read on near-term consumption trends, but at the moment, it’s up by 48% over the last year. Some customers are optimizing their spending with Snowflake to cut costs in this uncertain economic environment. That’s pressuring Snowflake’s revenue growth since its clients only pay for the resources they use, but these temporary headwinds offer investors an opportunity to build a position in the stock while it’s down.
Snowflake’s stock price has moved higher following its most recent earnings report, even though management lowered its full-year revenue guidance. Generative AI requires lots of data processing, which is Snowflake’s specialty.
Snowflake is already seeing the number of use cases involving AI, data science, and machine learning grow on its platform. More than 1,500 customers are already using these workloads, an increase of 91% year over year. Management was on point with last year’s acquisition of Applica, which uses language models to turn documents into structured data properties that can be referenced using analytics and AI. The company saw this opportunity coming and clearly positioned itself to capitalize on it.
While the company expects product revenue to increase just 34% this year, down from 70% growth last year, it’s possible Snowflake’s revenue growth could accelerate again in the next few years.
The stock is not cheap, trading at 25 times the company’s annualized revenue. But considering that pessimism in the markets is suppressing valuations for top cloud stocks right now, it would not be a bad idea to consider opening a small position.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. John Ballard has positions in Amazon.com. The Motley Fool has positions in and recommends Amazon.com, Microsoft, and Snowflake. The Motley Fool has a disclosure policy.